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2018 Federal Budget Passive Investment Income of CCPCs

On February 27, 2018, the Federal Minister of tabled its 2018 budget.   The most significant proposed amendment contained in the budget relates to the taxation of a Canadian Controlled Private Corporation’s (“CCPC”) investment income.  These rules will be applicable to taxation years that start after 2018. 

The main changes are as follows:

    • Reduction to the $500,000 small business deduction

There will be a reduction to a CCPC’s small business deduction to the extent that the adjusted aggregate investment earned by the CCPC and any corporation associated to the CCPC exceeds $50,000 for their previous taxation year that ended in the calendar year.  The reduction is $5 for every $1 that adjusted aggregate investment income exceeds $50,000. The small business deduction would, therefore, be reduced to zero once adjusted aggregate investment income reaches $150,000. 

For the purposes of determining if a corporation is associated under this rule, there is an anti-avoidance rule that deems a related but otherwise unassociated corporation to be associated if the corporation lends or transfers property to the related corporation and one of the reasons for the loan or transfer was to reduce adjusted aggregate investment income of the corporation.

Adjusted aggregate investment income is defined for this purpose.  It basically means investment income under the old definition with several adjustments to the definition.  The main adjustments include; exclusion of taxable capital gains and losses realized on an “active asset” of the corporation, net capital losses carried over from a prior year are not deducted for this purpose and will include dividends from non-connected corporations. 

Active asset is also defined for this purpose and includes an asset that was used in an active business carried on primarily in Canada by the corporation or a related CCPC. A share of the capital stock of a CCPC that is connected to the corporation and would meet the definition of a qualified small business corporation share for the purpose of the capital gains deduction.

    • Changes to the Refundable Dividend Tax on Hand Regime

There will now be two pools of refundable dividend tax on hand to keep track of, which are; eligible refundable dividend tax on hand (“ERDTOH”) and non-eligible refundable dividend tax on hand (“NRDTOH”).
ERDTOH includes eligible dividends received from non-connected corporation(s) and taxable dividends received from connected corporations to the extent such dividends cause a dividend refund to the connected corporation(s) from their ERDTOH.  NRDTOH basically means refundable dividend tax on hand under the old definition minus the RDTOH relating to ERDTOH.

There is a transitional rule that is interesting.  For the first taxation year beginning after 2018, the ERDTOH is calculated as the lesser of: the RDTOH on hand at the end of the previous taxation year less any RDTOH that was refunded in that year and, 38.33% of the corporation’s general rate income pool balance at the end of previous taxation year less eligible dividends paid in the preceding taxation year.  I have not yet had the opportunity to do the math if a company were to forgo some or all of its small business deduction in its taxation year-end that ends before its first year that begins in 2019, such that the general rate income pool balance would be increased and potentially therefore increase its ERDTOH.  Also consider whether it makes sense to trigger capital gains in the taxation year that ends before its first year that begins in 2019 to increase RDOTH.  Keep in mind that the capital gain triggered may reduce the small business deduction if investment income exceeds $50,000.

There is also an ordering rule in which eligible dividends paid cannot reduce NRDTOH. Non-eligible dividends must first reduce the NRDTOH pool before the ERDTOH pool can be reduced by a non-eligible dividend.

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